As Target Funds Falter, Pros Mull Options

By Sarah Morgan

Three years after they first blew up — then settled down — some financial advisers and industry experts still don’t know what to make of one of America’s most widely used retirement investments: so-called target-date funds.

As reported on Monday by SmartMoney.com, the funds, which have become a popular option in many company 401(k) plans, faltered again last year. The average fund with about four years to retirement fell 0.4%, and trailed major bond and stock indexes.

The poor performance comes after many of these funds revamped their portfolios to better protect investors after many posted even steeper losses in the market meltdown of 2008 — tweaks some retirement pros say clearly aren’t working. “In a year where bonds and fixed income investments clearly were the winner, those portfolios didn’t even earn money, on average,” says Kevin Mahn, the president and chief investment officer of Hennion & Walsh Asset Management. “That’s surprising.”

Critics point out that many of the funds — which invest in a mix of stocks and bonds and are designed to get more conservative as they near their “target,” or the year participants plan to retire — are failing to protect older investors. Indeed, some advisers say these participants could have done better on their own. For example, Micky Cargile, a managing partner of Cargile Investment Management, says an investor who split her portfolio into an S&P 500 index fund and a bond index fund would have gained about 5% last year. “You would have done better taking the time to select your own asset mix,” Cargile says.

To be sure, some 2015 funds managed to hit their targets. The John Hancock Funds II Retirement 2015 Portfolio, for example, landed at the top of the class this past year, gaining 5.5%. John Hancock had previously offered one of the more aggressive target date series on the market, but after 2008 they added this newer series, which allocates much less money to stocks at the point of retirement, says Bob Boyda, the portfolio manager for John Hancock’s asset allocation funds.

Meanwhile, the Wells Fargo Advantage Dow Jones Target 2015 fund gaining 3.1% for the year, and the American Century LIVESTRONG 2015 portfolio increased about 3%.

And some advisers defend the average performance of the 2015 class. Adviser Karl Mills, president of Jurika, Mills and Keifer, says that diversified portfolios, with both domestic and international stocks and bonds, suffered last year, but are likely to gain in the future. “The U.S. stock market doesn’t really tell the story of what happened last year,” he says.

But much of the 2015 class faltered in 2011. AllianceBernstein’s 2015 Retirement Strategy fund lost 2.8%, landing it near the bottom of the 2015 class, according to Morningstar data. The fund suffered in part because it holds more international stocks than peers in a year when international markets fell sharply, says Christopher Nikolich, the head of research and investment design for AllianceBernstein’s defined-contribution portfolios.

However, Nikolich says investors will be well served over long periods by the fund’s more aggressive stock allocation. Over the past three years, the fund is in the top 25% of its category, and since inception it’s near the middle of the group, Nikolich says.

The Goldman Sachs Retirement Strategies 2015 fund lost about 4%, according to Morningstar. This fund’s equity allocation is close to the 2015 group’s average, at about 56%, but that includes some more aggressive stock choices, including emerging market stocks, and international small-cap stocks, says Josh Charlson, a fund analyst with Morningstar. A spokeswoman for Goldman Sachs Asset Management declined to comment.

Regular investors should keep in mind that these funds vary widely in their allocation to stocks — from 10% to 55% — says Sasha Franger, a research analyst at Lipper. Some investors who are automatically enrolled in these funds, or only have one target-date option in their 401(k), may be getting more stock exposure than they think, she says.

And while retirement experts say target-date funds are still well-suited for investors without the knowledge or desire to select their own investments, many financial advisers recommend that more independent-minded investors build their own retirement portfolios. “They’re a good default, but don’t let yourself be one of those people who invest by default,” says Cargile.

Mahn adds that the funds simply aren’t customized enough to really fit with an individual investor’s risk tolerance and financial goals. Instead, investors would be better served working with the adviser associated with their 401(k) plan – or pick one on their own – to help design their retirement portfolio.

TDFs are a reasonably good idea, but with poor execution. 2008 and 2011 are proof that something is wrong. Here are some of the things that are wrong, and how they can be fixed.

(1) TDFs are used to package product. This explains the wide range of equity exposures at target date. Bond shops have 20% in equities while equity shops have 70% at target date.
(2) The objectives are to compensate for inadequate savings by taking too much risk.

The fix is simple. Fiduciaries need to insist on a safety-first objective. There is currently only one target date family in the US with this objective. Its 2010 fund was the best performing in 2011, earning 7.7%, and this should be noted in Sarah’s article.

11:01 pm January 11, 2012

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11:01 pm January 11, 2012

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